Pessimists say uncertainty over the price of oil -- or that of coal, which has also surged -- will impede development.

Output is now little more than a dribble, but with international crude prices as much as double the cost of producing oil from coal, the industry is gaining traction.

At least eight coal-to-liquids projects either are now under construction, or expected to get government approval in China, said Beijing-based CERA analyst James Brock.

Not all of them are designed to press out conventional fuel replacements -- their diverse output includes petrochemical feedstock and dimethyl ether (DME), touted as a potential alternative to diesel -- but will all sap oil demand.

"I see them substituting for 20 to 60 million tonnes (in a decade)," says Brock.

TECHNOLOGY RECOVERED

Liquefaction -- in which coal is usually crushed and heated to produce gas, then concentrated into liquid fuel -- was once seen as an expensive fallback of isolated regimes. Nazi Germany invested heavily, as did apartheid-era South Africa.

But high global crude oil prices, which rallied to over $58 in April and are seen averaging over $40 through to 2006, according to a Reuters poll, have spurred new interest from businesses.

It is among a host of oil alternatives -- such as ethanol and gas-to-liquids projects -- that have been given new life by oil's two-year boom that has doubled crude prices.

Chinese politicians are prepared to stump up cash as they worry over the reliance on oil from potentially unstable regions -- last year China imported over 40 percent of its needs -- and the prospect of a global race for resources needed to fuel growth.

Li Yongwang of Synfuels China, which is part of the Institute of Coal Chemistry, sees viably priced output reaching 10 million to 30 million tonnes a year (about 600,000 bpd) within a decade.

"With coal at around $10 a tonne, we are very confident we can get oil cost at about $25 per barrel," Li said. US crude oil prices have averaged just over $50 a barrel this year.

This compares with prices of under $20 a barrel from South Africa-based global industry leader Sasol, which produces around 160,000 bpd of coal-based liquids.

Li's institute, kept afloat by government funds during the 1990s when cheap oil dimmed interest in liquefaction, now gets around 60 percent of its funding from industry. Research partners include Volkswagen and DaimlerChrysler

Although foreign players are moving into China, domestic investment is the main driver, with local governments, business people and even coal mining firms interested in projects. Coal already provided up to 70 percent of China's energy needs, mostly for the power sector and steel industry. "We will see more foreign players coming in but slowly. China is moving because it needs (the technology) here and now," CERA's Brock said.

"This is an area where the Chinese are putting their money and that's what counts."

Liquefaction also suits another government agenda -- cutting pollution from dirty-burning coal -- although it does not reduce greenhouse-effect gases such as carbon dioxide.

PRICE DRAWBACKS

With over a trillion tonnes of the proven coal reserves lying under Chinese soil -- or more than 500 years of production at current levels -- liquefaction might seem an easy, reliable solution to China's energy dilemmas.

But it is a capital-intensive business, exposed to the possibility of a drop in oil prices or a rise in coal that could render plants uneconomical.

Royal Dutch/Shell recently started a feasibility study in China for what would be its first coal liquefaction project, but is wary of the risks.

"If coal prices continue to climb as they have been climbing over the last 18 to 24 months, it is a serious challenge... to see large volumes of coal-to-liquids projects," Thomas Chhoa, global manager for coal gasification at Shell, told Reuters.